Undergraduate Economic Review Volume 12 Issue 1 Article 4 2015 Cost - Benefit Analysis of the German High Speed Rail Network Martin Dorciak Lewis & Clark College, [email protected] Follow this and additional works at: https://digitalcommons.iwu.edu/uer Part of the Regional Economics Commons Recommended Citation Dorciak, Martin (2015) "Cost - Benefit Analysis of the German High Speed Rail Network," Undergraduate Economic Review: Vol. 12 : Iss. 1 , Article 4. Available at: https://digitalcommons.iwu.edu/uer/vol12/iss1/4 This Article is protected by copyright and/or related rights. It has been brought to you by Digital Commons @ IWU with permission from the rights-holder(s). You are free to use this material in any way that is permitted by the copyright and related rights legislation that applies to your use. For other uses you need to obtain permission from the rights-holder(s) directly, unless additional rights are indicated by a Creative Commons license in the record and/ or on the work itself. This material has been accepted for inclusion by faculty at Illinois Wesleyan University. For more information, please contact [email protected]. ©Copyright is owned by the author of this document. Cost - Benefit Analysis of the German High Speed Rail Network Abstract This study undertakes a cost-benefit analysis of the German ailwar y market looking specifically at the effects of high-speed rail development on railway passenger subsidies. Using OLS regression analysis, I estimate a demand curve for the German railway network at the route level; this is combined with cost curve estimates to yield a required subsidy for rail development assuming a natural monopoly market structure. I find that an increase in demand as a result of the introduction of high-speed rail technology causes a 23.9% decrease in required rail subsidies. Keywords Consumer Surplus, Cost Benefit, Cost Effective, Elasticity of Demand, Railways, Regional Transportation, Transportation This article is available in Undergraduate Economic Review: https://digitalcommons.iwu.edu/uer/vol12/iss1/4 Dorciak: German High Speed Rail 1 Introduction Medium distance travel offers the widest array of choices for travellers in terms of modes of transport. Within the past 30 years, the advent of high-speed rail technology has once again enabled rail to be a player in medium distance travel of 200 to 500 miles, enabling railways to compete with the currently more appealing modes of cars and planes by reducing the costs and travel time associated with rail travel. The current developments in railway transport have allowed rail to increase its modal share relative to the other two modes, where modal share is the percentage of passengers that utilize one mode relative to all available options. The main motivation of this study is to estimate the impact of high-speed rail (henceforth referred to as HSR) technology on the demand for rail transport and compare this with the costs of implementing HSR. Then I comment on the viability of HSR as an alternative option to air and vehicular travel. I will look specifically at the case of Germany and comment on the effectiveness of the German HSR experience in terms of costs and benefits. The roots of HSR analysis come from transport economics and valuations of travel time and fare prices and how they affect consumer demand. Given a choice of modes on a given route, consumers choose the mode that minimizes the total trip cost, which equals the sum of the fare, the cost of preliminary transit (transit to a station/airport), wait times, and the cost of the actual travel time itself. In the specific valuation of transportation demand, the primary method is that of an aggregate transportation model, where "the demand for a given [mode in] the travel market is explained as a function of Published by Digital Commons @ IWU, 2015 1 Undergraduate Economic Review, Vol. 12 [2015], Iss. 1, Art. 4 variables that describe the product or its consumers" (Small, 1992: 6). This derivation of transport demand can be focused even further as in Domencich and Krafts (1970) approach of direct demand modeling, where the dataset to be analyzed is comprised of pairs of locations forming various routes in a city or region from which travel statistics such as ridership figures, fare prices, and regional statistics are regressed to determine an explicit demand curve for the specified region. I will employ this particular method to estimate demand, focusing on a route level analysis of the German railway network while also differentiating between routes that have HSR service and routes that do not. On the supply side, looking at costs and market structures further reveal key motivations for this study. The predominant market structure for railroad systems is that of a natural monopoly, where large economies of scale and prohibitively high startup costs limit the number of firms to one. Even then however, the suppliers of rail service typically require subsidization to prevent travel costs from being prohibitively high for the consumer. Mohring (1972) provides a theoretical framework for optimal subsidization levels in public transport and posits that if the average riders opportunity cost of travel time is below the marginal cost of operating a transport system, then to make marginal cost pricing viable transport providers would have to subsidize fares to a level that equals the opportunity cost of the passengers time. This can also be intuited in the case of the monopolistic railway networks. But rather than subsidizing a consumers time, production costs must be subsidized to make monopoly pricing viable. This issue is certainly relevant to current political debates, with developments https://digitalcommons.iwu.edu/uer/vol12/iss1/4 2 Dorciak: German High Speed Rail proposed in California and Texas funded by an 8 billion dollar allotment from the 2009 American Recovery and Reinvestment Act (Peterman, 2009). Currently, several Central and Western European countries have developed HSR networks with varying degrees of coverage that offer travellers overall travel times which are shorter than flying or driving at comparable or lower prices for medium distances of 100 to 500 miles with almost exclusive provision of services through state owned monopolies who in turn subsidize construction costs and fares with government money. This is indicative of the motivations behind my analysis, as it is in the interest of national governments to pursue HSR development policies; I aim to comment on the viability of these developments. The core of my analysis will focus on the derivation of the demand and cost curves through a regression analysis of German rail statistics, specifically focusing on observations of city pairs where the quantity of rail transport demanded is represented by the route ridership and price is represented by the total cost to passengers on the given route. Additional variables include a dummy variable indicating the presence of HSR on a given route to differentiate between base level rail demand and high speed rail demand, average population density of the departure and arrival destinations, average GDP per capita of departure and arrival destinations, and travel times and fare prices of the primary competitor in that of air travel. The analysis combines this market demand curve (equal to marginal benefit) with costs incurred by the monopolist firm to determine the socially optimal level of HSR utilization for the German market and comment on discrepancies between optimal and actual levels of ridership and commensurate subsidy Published by Digital Commons @ IWU, 2015 3 Undergraduate Economic Review, Vol. 12 [2015], Iss. 1, Art. 4 levels. The paper will proceed as follows. Section 2 reviews the literature in the field looking at general theories of transportation economics as they pertain to institutionally provided transport and subsidization of said transport, and specific applications of HSR analyses estimating costs, demand, and societal benefits. Section 3 presents the economic framework typical to the state monopolist market present in Germany and equates curves in the ideal model with their function in my analysis. Section 4 presents the data and regression analysis to derive the demand curve and the specification of cost curves and section 5 represents these graphically and determines the optimal level of utilization and compares this with observed levels. 2 Literature Review Mohring (1972) develops a model that illustrates the role of subsidization in public transport systems and then applies his model to travel statistics for city busses in the Minneapolis St. Paul area. Mohring provides a general base for analysis of transport subsidization, and additionally provides specification of several key cost variables. First, Mohring notes how transport pricing deviates from traditional price theory models, where travellers also provide an input into the final cost calculations in that of their travel time. This makes the total cost to consumers of utilizing transport the fare that is charged in addition to the opportunity cost of the journey for the consumer. The model presented by Mohring is presented below on the folowing page in Figure 1. https://digitalcommons.iwu.edu/uer/vol12/iss1/4 4 Dorciak: German High Speed Rail Figure 1: Bus Transport Subsidies The commodity detailed in the graph is bus rides; as such, cost is represented as dollars per bus ride and quantity as bus rides per week, with curves representing short run and long run marginal costs, long run average costs, and average variable costs. Mohring assumes this form without alteration [describes] bus operations that are subject to increasing returns and can be applied practically to metropolitan transit systems (Mohring, 592, 1972). Additionally, a demand curve is implied as intersecting marginal costs at point C. This model reconciles both the inputs of the consumer in that of travel time and the producer in that of the bus system and widgets are transformed into journeys.